The proliferation of fintech could result in greater pressure on banks’ business models, resulting in loss of market share, increased cyber risks and higher cost of equity than predicted – according to the Financial Policy Committee (FPC).

The insights were revealed in records of FPC meetings held on 22 and 27 November 2017, which reviewed conclusions gained from the Bank of England’s (BoE) first biennial exploratory scenario (BES) – an examination of major UK banks’ long-term strategic responses to an extended low growth, low interest rate environment with “increasing competitive pressures from fintech.”

The FPC found that although banks projected that they could adapt to a low rate, low growth macroeconomic environment without major strategic change, the sustainability of incumbent banks’ business models are at risk of facing “greater and faster disruptions” from fintech than they project.

“It was not clear that the [banks’] projections had fully reflected the range of potential impacts of fintech,” the reported noted.

The FPC said innovation in financial technologies is creating new opportunities for consumers, banks and other businesses alike. With particular reference to Open Banking, the report noted that fintech could offer benefits such as better information and access to services, as well as more competitive pricing and alternative credit sources like peer-to-peer lending.

While fintech could allow banks to achieve cost savings, the report also said that the increased competition might reduce the scope for cost reductions or result in greater loss of market share – and may result in “profound consequences” for major banks.

“The resilience of the banking system to future shocks [does] not only depend on current capital resources, but also on the sustainability of banks’ business models,” said the FPC.

Risks and volatility

The FPC said that aspects of fintech such as the Payment Services Directive 2 could make retail deposits a less stable source of funding for banks, as the directive would allow customers to use regulated third party platforms to monitor multiple bank accounts and initiate payments.

However, its nature could also increase cyber risks by creating more avenues for digital threats – the implications of which are many and varying.

“Competition from new fintech firms could turn some banks into low-risk utilities with a low cost of equity, while banks that embraced new technologies might see additional earnings volatility and higher costs of equity,” noted the report.

And although the report emphasised that before any new service providers are authorised, the FCA looks at applicants’ security policies, governance, business continuity arrangements and controls around access to sensitive data – it also said that fintech might nevertheless “increase all banks’ cost of equity by exposing them to additional cyber risk.”

“In light of these factors,” the report continued, “the FPC concluded that the cost of equity for banks might be higher than the 8% level they expected in this scenario. This could put additional pressures on banks’ business models if such a scenario were to materialise.”

The FPC said it would engage in further work to consider the results of the study, and noted that supervisors would discuss the results with banks, including the potential implication of these risks.

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